Back in 2019, an estimated 99% of crypto-asset transfers took place on centralized exchanges (CEXs), according to the number that was used by main crypto critic Nouriel Roubini. CEXs are likely to remain a central fixture of the crypto trading landscape for the foreseeable future. CEXs are fast and convenient, but typically require traders to deposit funds in an account controlled by the exchange. Unfortunately, history illustrates that this loss of sovereignty over a user’s digital assets can be an extreme and costly compromise.
Decentralized exchanges (DEXs) offer an intriguing alternative and are gaining momentum, but are still not yet ready for prime time. Therefore, there must be a way to bridge the gap between user sovereignty and exchange performance.
When it comes to custody, control is better than trust
The nightmare scenario for traders using CEXs is that they might fall victim to hacking or fraud and lose their deposited funds. Although seven years have passed since the collapse of Mt. Gox in 2014, its name still remains synonymous with the dangers of cryptocurrency fraud. Once the world’s largest Bitcoin (BTC) exchange, it filed for bankruptcy in 2014 after Bitcoin of an estimated 650,000 customers went missing. The victims are still attempting to receive partial compensation from the insolvency process in 2021.
Sadly, this form of counterparty risk remains a threat to this day. In April, the founder of Turkish exchange Thodex absconded with $2 billion of investor assets unaccounted for. A year before that, China’s FCoin and Australia’s ACX both closed without warning. Whether those failures were due to fraud, a hack, or problems with the business model, it doesn’t matter much to the investors left out of pocket. In an ideal world, the exchange operator (or a hacker who has compromised an exchange) should be denied the ability to move client funds discretionarily…